(Bloomberg) -- Investors are increasingly betting on fewer interest-rate cuts by the Bank of England next year, putting them at odds with official guidance ahead of the central bank’s decision Thursday.
Money markets see just 52 basis points of monetary easing in 2025, down from over 70 basis points on Monday. That contrasts with the 100 basis points indicated as a base case by a number of officials in the BOE’s Monetary Policy Committee.
The divergence between traders’ outlook and those of policymakers raises the stakes ahead of Thursday’s decision, with the potential for rate-setters to push back on market pricing in the coming days. All except one economist polled by Bloomberg expect the central bank to hold its key rate steady at 4.75%, putting focus firmly on forward guidance.
“Markets have gone too far in pricing in only two cuts for next year, meaning the MPC will likely aim to peddle a slightly dovish tone in tomorrow’s meeting,” said Gabriella Dickens, an economist at AXA Investment Managers, who expects four BOE rate cuts in 2025.
The repricing toward fewer cuts started on Tuesday as UK employment data suggested wages increased more than forecast, fanning concerns of lingering inflationary pressures. While consumer prices figures Wednesday came in line with economists’ expectations, that offered little relief given services inflation — closely watched by the BOE for signs of lingering pressures — remains stubbornly high at 5%.
“Today’s data will only reinforce the MPC’s message of patience and gradualism,” said Sanjay Raja, Deutsche Bank AG UK economist. “Put bluntly, the MPC is some way away from declaring victory on inflation.”
The dramatic moves may have been exacerbated by market conditions, with sterling rates traders bemoaning thin liquidity following key data releases. A reversal in pricing on Wednesday coincided with a surge in trading in SONIA contracts amid positioning for the BOE decision, as well as the Federal Reserve meeting later on the day. Volumes in three-month futures hit the highest over a half-hour period since Dec. 4.
BOE Caution
While the BOE has cut rates just twice this year, trailing peers including the European Central Bank and the Fed, the evidence this week emboldened the market to price in even greater caution from UK policymakers. The chance of a quarter-point cut in February fell to 57% from 80% on Monday.
The UK central bank stance has supported the pound, which has outperformed all other Group-of-10 currencies against the dollar this year. Yet its cautious tone has weighed on gilts and exacerbated their underperformance, widening the gulf between yields on government bonds in the UK and Germany to levels last seen in 1990.
The yield on two-year gilts, among the most sensitive to monetary policy, rose 16 basis points so far this week to 4.46% on Wednesday, while the 10-year yield jumped 15 basis points to 4.56%. The pound is up 0.6%, trading just below $1.27.
While it’s hard to predict what gilts might do in the coming months, the “brutal” adjustment merits some consideration, said Felipe Villarroel, portfolio manager at TwentyFour Asset Management.
“For all the uncertainty surrounding some UK data, 10-year gilt yields could well start 2025 100bps wider than they started 2024, something that is definitely worth keeping in mind in a year where carry is likely to be the main contributor to returns,” he said.
What Bloomberg Strategists Say...
“The big-picture takeaway is that core inflation around 3.5% and services reading at 5% can barely inspire much confidence in the Bank of England to keep cutting interest rates...With the two-year breakeven rate holding above 3.20%, gilts traders will continue to be wary of pricing too many rate cuts.”
— Ven Ram, Cross-Assets Strategist, Dubai
Some investors argue that the latest figures will reinforce fears of so-called “stagflation” — a high inflation, low growth scenario that presents a significant challenge for policymakers. Data last week showed the economy unexpectedly contracted.
“The UK stagflation risks are clear and the BOE tomorrow may be more important to global mood than the expected Fed easing today,” said Bob Savage, head of markets strategy at BNY Mellon.
--With assistance from James Hirai.
(Updates throughout with closing prices, details of Thursday’s meeting.)
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